D&O Insurance: No Coverage for Attorney Fee Award to Underlying Plaintiffs if Underlying Claim Not Covered

Does a D&O insurance policy provide coverage for attorneys’ fees awarded in settlement of a breach of contract class action? That was the question before the court in an insurance coverage action brought by the Screen Actors Guild (SAG) against its D&O insurer. In a July 11, 2013 decision, Central District of California Judge Dolly M. Gee, applying California law, held that because there was no coverage under the policy for the underlying breach of contract claim, the policy did not cover the attorneys’ fee award either.

A copy of Judge Gee’s opinion can be found here. A July 19, 2013 memo from the Baker Hostetler law firm about the ruling can be found here.

Background

Prior to the events that gave rise to the coverage dispute, SAG had entered a collective bargaining agreement in which the actors’ organization had agreed to collect foreign royalty payments and to distribute them to its members. In September 2007, Ken Osmond (who played the part of Eddie Haskell in the TV show “Leave it to Beaver”) filed a class action alleging that SAG had collected over $8 million of the foreign levies but had failed to remit the funds to the SAG members. Osmond asserted claims for conversion, unjust enrichment, accounting and violation of the California Business Code. Osmond sought restitutionary relief, compensatory and punitive damages, a constructive trust, costs, reasonable attorneys’ fees, prejudgment interest and injunctive relief.

SAG tendered the claim to its D&O insurer, which agreed to pay defense cost but denied coverage for any indemnity amounts. The parties to the underlying dispute reached a settlement agreement whereby SAG agreed to a plan for the payment of the foreign levies. In approving the class settlement, the court in the underlying claim awarded Osmond an enhancement payment of $15,000 and awarded class counsel attorneys’ fees of $315,000. SAG requested reimbursement from its D&O insurer for the $330,000 award. The carrier responded that the fee award was not covered under the policy. SAG initiated coverage litigation against the carrier and the parties cross-moved for summary judgment.

The July 11, 2013 Order

In a July 11 Order, Judge Gee granted the carriers’ motion for summary judgment and denied SAG’s cross-motion for summary judgment.

Referring to the 2012 decision of the California Intermediate appellate court in Health Net, Inc. v. RLI Ins. Co., as well as other California cases, Judge Gee identified a principle under California law that the courts had articulated, which is that “if a contracting party fails to pay amounts due under a lawful contract and is sued for that failure to pay, it cannot then obtain a windfall by having its payments covered by an insurance policy covering only ‘wrongful act.’”

SAG attempted to circumvent these principles by contrasting the specific language in its policy with the policy language at issue in the earlier cases and arguing that its policy broadly provided coverage for “damages.” Judge Gee found said that this argument “is not persuasive.” She found that the definition of the term “Wrongful Act” in SAG’s policy was similar to the definition of the term in the policies at issue in the prior cases. Judge Gee expressly rejected the notion that there could be coverage for attorneys’ fees as “damages” if there was no underlying “Wrongful Act” alleged. She cited the Health Net decision for the principle that “if the entire action alleges no covered wrongful act under the policy, coverage cannot be bootstrapped based solely on a claim for attorney’s fees.”

Judge Gee found that the parties’ submissions and even from SAG’s own presentation in the insurance coverage dispute lead to “but one result,” which is that because SAG was “obligated to account for and distribute the foreign levy funds to the plaintiff class,” SAG “failed to establish that the $330,000 fee award arises from a ‘covered’ Claim under the Policy.” She concluded that the insurer has no duty to indemnify SAG for the fee award and she granted summary judgment in the insurer’s favor.

Discussion

This dispute involved two frequently recurring D&O insurance coverage issues: first, whether a D&O policy covers breach of contract disputes; and second, whether or not a D&O insurance policy covers the amount of an award to the plaintiffs’ attorneys in an underlying claim.

Many D&O insurance policies (typically those issued to private companies) have express exclusions precluding coverage for breach of contract claims (as discussed here and here). However, Judge Gee’s decision here that there was no coverage for the underlying claim here did not depend on her interpretation of a policy exclusion; instead, she found that there was no coverage for the underlying claims against the SAG – for collecting but failing to remit the foreign levies – because the underlying claim did not allege a “Wrongful Act.”

There have been many cases holding that insurers are not liable to indemnify their insureds for claims against the insureds for failing to remit amounts the insured was obligated to pay to others. However, these determinations are typically based on the argument that in remitting the amounts due, the insured had not incurred a “Loss” under the policy. These “no loss” principles are fairly well established, as recently discussed for example here. Typically these cases hold that amounts due as a result of a pre-existing duty are not covered Loss

It is interesting that Judge Gee’s analysis here did not depend on, or even refer to, the “no loss” line of cases; the carrier, in reliance on existing California case law, made a different argument, obviously because it could (owing to the case law), but also perhaps because the existence of the $330,000 fee award might have made the “no loss” argument tougher to sustain. Indeed, the SAG did argue here that because fee award represented “damages” and therefore came within the policy’s definition of “Loss.” Judge Gee concluded, in reliance on the prior California cases, that it doesn’t matter whether or not there is “Loss” if there is no “Wrongful Act.”

The question whether or not a D&O insurance policy provides coverage for the amount of a plaintiffs’ fee award in an underlying claim is a recurring issue. As I discussed in a recent post, this question often comes up in the context of the settlement of shareholders’ derivative lawsuits, which often include a plaintiffs’ fee award as a part of the underlying settlement. The D&O insurers often argue that the amount of the fee award does not represent “damages” or otherwise is outside the policy definition of Loss. The insurer argue that the fee award represents an amount the company had to pay in order to secure the benefit that inured to the company in the derivative lawsuit settlement.

There are several obvious differences between the derivative lawsuit settlement context and the circumstances involved in this case. Among other thing, in connection with a derivative lawsuit, the carrier has usually acknowledged coverage of the underlying claim. In addition, in a derivative lawsuit settlement, the carrier has the argument that the derivative settlement represented a benefit secured for the insured company; the context in this dispute was far different. The present dispute does illustrate another example of the recurring question of coverage for the amount of an attorneys’ fee award in connection with the settlement of an underlying claim.

Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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